client login | become a branch office | contact us   



Byrne Investment Services, Inc.
16351 Falmouth Drive
Strongsville, OH 44136
Telephone: 440.238.9552 or 800.250.3450
Fax: 866.247.5754

About Scale Trading

CALCULATING CAPITAL REQUIRED
WHAT CAN GO WRONG?
WHY YOU CAN'T SCALE TRADE FROM SHORT SIDE
WHAT'S THE LIFE OF A SCALE?
WHY CAN YOU LOSE MONEY SCALE TRADING?
WHAT TO EXPECT
WHAT DOES BYRNE INVESTMENTS OFFER?
WHAT SHOULD I DO?


Scale Trading is a disciplined, mechanical approach to buying low and selling high. It is based on the economic law of Supply and Demand, built on the premise that a physical commodity has an intrinsic value and, therefore, will not likely become valueless. For example, if the price of corn falls below the cost of its production, growers will be motivated to cut back or switch to another more profitable crop, thereby reducing the available supply for the coming year. As supply shrinks, price eventually moves higher to ration demand. This in turn attracts producers to increase production, thereby increasing supply, and the process starts all over again.

The concept of intrinsic value does not necessarily apply to other investments. For instance, the stock of today's hot company could actually go to zero due to any number of micro or macro economic circumstances, while a bushel of corn has an intrinsic value virtually assuring that its price will not go to zero.

The beauty of the Scale Trading approach is that we can outline our trading plan ahead of time by carefully evaluating current supply/demand statistics and then comparing those with the commodity's historical price range. This gives us the ability to then pinpoint the price at which we want to begin our scale down buying and, most importantly, calculate the total capital we will likely need to maintain that scale under our worst case scenario.

By sticking with "Mother Nature" commodities, particularly those which are grown for human consumption, we ensure that even the worst case scenario will eventually give way to a recovery in prices. While our worst case scenario does not represent a guarantee of what our ultimate exposure will be, the principles that drive the law of supply and demand are the best tools we have found for long term success in the commodity markets.

SCALE TRADING QUESTIONS AND ANSWERS

The Scale Method: Selecting and Managing a Scale.
  1. Look for a commodity that is trading at or near historically low levels, ideally in the lower 30% of its historical trading range.
  2. Complete a thorough review of the fundamental factors influencing the commodity in question. What are the short and long term supply/demand expectations for the commodity? Do they support an assumption of the commodity holding at or above its historical lows?
  3. Evaluate the seasonality of the commodity in question. Seasonal pattern charts are available for most agricultural markets such as corn and beans. Timing when to start a scale can make a big difference in the performance of your scale account.
  4. Enter limit orders GTC (Good till Canceled) to purchase the commodity (going long, never short) on an incremental scale all the way down to a level determined to be a "worst case" scenario. Stops are not used to limit risk.
  5. As each buy order fills, enter a limit sell order to close out the position at a pre-determined price that normally captures a $250-400 profit (net of fees and commissions), although this will vary depending on your personality and market conditions.
  6. As each sell order is filled re-enter the limit buy order at the original scale purchase price.
  7. Continue along this path until the commodity you are Scale Trading bottoms and rallies up to the point at which your first contract purchased is sold. You have now completed your first scale. (See sample Scale Trading plan at the back of this brochure.)

How to Calculate The Amount of Capital Required

Two factors determine the capital required for your scale. How wide or narrow your buying increments are, and the margin requirement for each contract purchased. We used a worksheet, but the calculations can be done by hand. We use the maintenance margin for our calculation. It is important to keep in mind that margin requirements can change without notice.

What Can Go Wrong?

In selecting the scale parameters we have evaluated current supply/demand fundamentals and determined that the commodity is in the lower 30% of its historical trading range. Based on that assessment we come up with our buy/sell lines and the capital required to maintain the scale. BUT, what if the fundamentals change drastically and the price falls below our worst case scenario? If you scale trade for any length of time this situation will eventually occur to some degree or the other. This will be a hair-raising experience. However, there is no problem as long as you have adequate capital reserves to back your position and the world still has a demand for the commodity. We like to use three possible downside targets when planning our scales:
  • The most likely low that analysis suggests.
  • The lowest conceivable price under the worst imaginable circumstances.
  • A price 15-30% lower than our worst case scenario.

Obviously, if you run out of money you will be forced out of the market and will lose the lion's share of your capital allocated for that scale. In an extreme situation, such as that wheat was linked to cancer in humans, then obviously we would most likely get out and take the loss. In the absence of such an extreme, however, the law of supply and demand should eventually work the price of the commodity back in your favor. You should have a clear understanding that scale trading is not a free lunch, we do have risk. The primary risk we have is that the law of supply/demand would somehow stop working. While this routinely seems to occur in the short run, it is very unlikely to happen in the long run.

Why Can't You Scale Trade From the Short Side?

All markets have a downside limit of zero and a likely downside around their cost of production. However, what is the upside limit to a market? The fact is it is very difficult to determine the upside limit. Under the right circumstances, prices can greatly exceed previous highs. What would have happened if you had been short scaling soybeans in 1973? Prior to the end of 1972, the highest all time price for beans was $3.75 per bushel. In 1973, the price went to $12.90 per bushel. While the price has never returned to those levels, we can reasonably expect that at some point in the future soybeans will exceed those levels. Only if you scale trade from the long side can you determine the approximate risk you are taking and manage it appropriately.

What is the Life of a Scale/ What If My Contract Goes Off the Board?

If by first notice day you are still holding contracts in your scale, you must execute a "rollover". In a rollover you close out your positions in one contract month and reestablish the trade in a later month. When a rollover is completed you will realize the paper losses you have been carrying in the scale and enter into the new contracts at the then current price. Your sell orders for these new contracts are established in the new contract month. In any scale, you want to trade in a later month that offers the price, volatility, liquidity and time you need to close out your scale.

Why Can You Lose Money Scale Trading?

In our experience the primary reason people lose money scale trading is that they let their ego get ahead of their pocketbook. They either pursue too many scales at one time or they get too aggressive in one scale. An important point to consider before you begin Scale Trading is how much "emotional capital" you have. Almost everyone enjoys Scale Trading when they are buying and selling in the top 1/3 of their scale. They are buying and selling and buying and selling and don't seem to care which way the market goes. It is at the point where you enter the bottom 2/3rds of your scale that the going gets tough. It is important to assess your level of tolerance for large drawdowns in equity as well as drawdowns in your emotional capital.

In our experience, people who lose using this method lose because they bail out, frequently right at the lows, having been influenced by the thinking of the experts that "this time is different" and that silver is going to $2.80/oz. or Crude to $8.00/barrel. While potentially this can happen, (and you would be well advised to be prepared for that possibility), you would be much better served by instead confirming adequate cash reserves and then re-affirming your belief in the principles driving the law of supply and demand.

What To Expect From My Scale Trading Brokerage

Make sure the firm you choose has experience with Scale Trading. Like any methodology there are fine points and idiosyncrasies that need to be addressed. The execution of your scale by your broker can require close monitoring, so it is important that other brokers in the office also understand scale trading and be able to fill in when your broker is at lunch or on vacation. Your broker should be able to provide you with long term fundamental information on the scales you are pursuing. Day to day fundamentals are not nearly as important.

What Does Byrne Investment Offer?
  • Byrne Investments has a wide range of experience in scale trading many different markets.
  • A significant percentage of Byrne Investments clients are Scale Traders so we devote a large amount of our time and research to its proper implementation and execution. You can take advantage of the knowledge gained through years of Scale Trading experience.
  • Byrne Investments spends the time necessary with each client so that they understand their risks as well as the rewards regarding their trading. We feel it is important for you to know what is happening with your investment capital.
If I Want to Pursue Scale Trading, What Should I Do?
  • Call Byrne Investments at 1-800-250-3450 and get whatever answers you need to feel comfortable with Scale Trading.
  • Let the broker know what level of capital you have to work with and get a sense of what scales might be appropriate for you.


PLEASE REMEMBER THAT COMMODITY TRADING INVOLVES A HIGH DEGREE OF LEVERAGE. THAT LEVERAGE ALLOWS FOR LARGE RETURNS, BUT ALSO LARGE LOSSES. DUE TO THE HIGH DEGREE OF RISK INVOLVED IN HIGH LEVERAGE, YOU SHOULD CAREFULLY CONSIDER WHETHER COMMODITY TRADING IS APPROPRIATE FOR YOU.

© Copyright 2001-2007 Byrne Investments, Inc. All rights reserved.

All logos, symbols and information contained on this site are the property of their respective owners and authors.